1. By this reference under section 66(1) of the Income-tax Act, 1922, the following question is referred to us for determination :
'Whether, on the facts and in the circumstances of the case, the sums of Rs. 4,38,472 and Rs. 2,27,342 were properly held to be capital profits ?'
2. This reference arises out of the assessment for the assessment years 1952-53 and 1953-54, the relevant previous years being the years ending October 31, 1951, and October 31, 1952, respectively. During these assessment years, the assessee was a private limited company and its share capital was held by the members of the Mahindra family and their nominees. The assessee-company's business consisted, amongst others, in import and sale of diesel engines.
3. In or about the year 1947, the assessee-company came across a suggestion regarding manufacture of diesel engines in India, for lift irrigation purpose from one Kilberi, an American citizen. The said manufacture was to be done with the machinery to be acquired from an American company called vess Seven in Machine Company Inc. (hereinafter referred to as 'the machine company'). The machine company was in financial difficulties and a committee of creditors was appointed for proper distribution of its assets. In December, 1947, the assessee-company presented a scheme to the Government of India for manufacture of diesel engines. In December, 1947, a conference was held between the representatives of the assessee-company and those of the Government of India. As a result of this conference, the scheme propounded by the assessee-company was accepted and it was decided to sanction foreign exchange to the tune of five lakhs U. S. dollars. Permission was granted to the assessee-company for purchase of plant of the machine company for having it installed in India and thereafter the assessee-company was required to start manufacture of diesel engines. The import of machinery was contemplated to take place on or before June 30, 1949. As a part of the scheme, the assessee-company desired that Government should place with a firm order for purchase of 1,000 diesel engines. The Government decided to place an order for 250 engines and for the balance, orders were to be placed as and when capable. In view of the decision, the Government wrote to the Reserve Bank stating that it has sanctioned the remittance to the assessee-company of five lakhs U. S. dollars for purchase of machine company, a company manufacturing complete diesel engines, on the understanding that the machinery and plant covered by the purchase are transferred to India by the 30th of June, 1949.
4. For the purpose of carrying out this project, the assessee-company floated another company in India in May, 1948, and the business was to be carried on in Calcutta. Between February, 1948, and August, 1948, 4,50,000 dollars were remitted to America. The balance of 50,000 dollars out of the sanctioned foreign exchange was kept reserved for payment of freight, shipping charges, etc.
5.The capital of the machine company was 30,000 U. S. dollars divided into 250 shares of 120 dollars each. On February 11, 1948, the assessee-company entered into an agreement with the shareholders of the machine company and purchased the entire share capital for 30,000 dollars. The balance of 4,20,000 dollars was paid over to the machine company as loan and a promissory note for the amount was taken. The machine company floated a new company as it subsidiary called Venn Seven in company (hereinafter called as the 'new company'). Capital of the new company was to consist of 10,000 dollars. Upon incorporation of the new company the entire machinery and other assets of the book value of 4,75,646 dollars were transferred by the machine company to the new company in exchange for 100 shares of 100 dollars each allotted to the machine company. After adjusting the sum of 10,000 dollars in the share capital account the new company showed the balance of 4,65,646 dollars as a 'paid in surplus' - a kind of capital reserve. Thereafter, the machine company transferred 100 shares of the new company to the assessee-company and the loan of 4,20,000 dollars made to it by the assessee-company was treated as discharged. After this transaction, the entire share capital of the new company was held by the assessee-company. It appears that in or about the year 1948, 86 diesel engines were sold to the Bombay Government but these engines were not found suitable to Indian conditions. The assessee-company did not succeed in its efforts with the Government to secure a firm order. Consequently, in the year 1949, the project for manufacture of diesel engines in India with the help of the said machinery was abandoned. The assessee-company repatriated to India 1,00,000 dollars on October 10, 1949, and 1,25,000 dollars on October 27, 1949. The pound sterling was devalued in September, 1949, and the rupee was also simultaneously devalued. The rupee value of 2,25,000 dollars remitted to India after the devaluation came to Rs. 10,68,500. This capital is paid out of the paid in surplus in the new company. Thereafter, between July, 1951, and October, 1952, there was remittances aggregating to 2,30,562 dollars. These remittances were from the sale proceeds of 100 shares held by the assessee in the new company and 137 shares in the machine company. The remaining 113 shares in the machine company were held by Kilberi and Webster. They were given to them for the help rendered by them to the assessee-company in October 1949. As a result of these remittances during the relevant years, there were surplus realisations of Rs. 4,38,472 and Rs. 2,27,342, respectively, in the relevant previous years. At the time when the assessee-company was assessed by the Income-tax Officer, all relevant fats material to this transaction were not available to the Income-tax Officer. It was, however, contended by the assessee-company before the Income-tax Officer that the whole transaction was one of a capital nature, but that contention was not accepted by him and he subjected both these amounts to tax in the two assessment years.
6. In the appeals filed by the assessee-company for these two years, the Appellate Assistant Commissioner remanded the case and called for a report from the income-tax Officer. After the remand report, the matter was considered by the Appellate Assistant Commissioner and he held that the profits realised by the assessee-company as a result of the liquidation of the investments and remittances thereof to India represented capital gains. He, therefore, took the view that neither the sum of Rs. 4,38,472 nor the sum of Rs. 2,27,342 was subject to tax. On an appeal by the revenue the Income-tax Tribunal confirmed the finding of the Appellate Assistant Commissioner that the transaction was a capital gain and that the surplus was not taxable.
7. Mr. Harjarnavis, on behalf of the revenue, contended that the transaction substantially was in the nature of a trading activity; that the assessee-company wanted the transaction for purchase of plant and machinery to be tied up with an order for sale of 1,000 diesel engines to the Government. He also pointed out that it is apparent from the remand report submitted by the Income-tax Officer that the value of the fixed assets of the machine company was only 39,471 dollars whereas the value of the finished parts and goods as on July 31, 1948, was at 3,34,807 dollars. He also pointed out that in purchasing 250 shares of the machine company only a sum of 30,000 dollars was utilised while the balance of 4,20,000 dollars was given by way of loan for which a promissory note was passed by the machine company. He submitted that every accretion invested in trade is income, and the two sums of Rs. 4,38,472 and Rs. 2,27,342 cannot be regarded as capital gains or profits but that they should be regarded as income to the assessee-company.
8. As we are not satisfied with the contentions urged on behalf of the revenue, we have not called upon the counsel for the assessee-company to reply. However, counsel for the assessee stated that the correctness of the figures supplied and relied upon by the revenue is not accepted by the assessee-company.
9. It is well settled that a receipt is not taxable when it is a fixed capital. It is taxable as a revenue item when it is referable to circulating capital or stock-in-trade. The fixed capital is what the owner turns to profit by keeping it in his own possession. Circulating capital is what he makes profit of by parting with it and letting it change its masters. The entire nature of the transaction has been analysed by the Appellate Assistant Commissioner and by the Tribunal in their respective orders. The project of the assessee-company was to establish a factory for manufacture of diesel engines in India and for that purpose to import requisite plant and machinery in india. That factory was intended to be established as shown by the correspondence with the Government prior to June 30, 1949. The project had, however, to be abandoned because 86 diesel engines which were sold to the Government were found unsuitable for conditions in India. The assets of the machine company consisted partly of plant and machinery and partly of finished parts and goods. But the assessee-company only purchased all the 250 shares of the machine company and advanced to it as and by way of loan a sum of 4,20,000 dollars on a promissory note. The assessee-company never traded in the shares of the machine company and the purchase thereof did not form part of its trading activity. The purchase of shares of the machine company does not mean purchase of stock-in-trade of that company. The machine company continued its business and sales of its products. The profits and loss belonged to that company. A shareholder of the machine company had merely a right to get dividends, if they were declared. When the project was abandoned all the 100 shares of the new company and 137 shares of the machine company were sold. The profits realised as a result of liquidation of the investments and the remittances thereof to India thus remains the capital gain.
10. Between October, 1949, and October, 1952, a total sum of 4,55,562 dollars was remitted to India. These remittances commenced after the assessee-company agreed to sell its holding of 100 shares in the new company and 137 shares in the machine company to J. J. Sugarman & Co. As the order of the Tribunal shows, the proceeds of the 100 shares of the new company were 1,50,000 dollars and those of 137 shares of the machine company were 91,333.33 dollars. The proceeds of the sale of these shares amount to 2,41,333.33 dollars. The investment in these shares is not a trading activity of the company. If the difference between 4,55,562 dollars and 2,41,333.33 dollars is regarded as the payment made towards the loan of 4,20,000 dollars, even then there is no income whatsoever because the amount so repaid is much less than the principal amount.
11. As shown in the statement of case at no stage the revenue had taken up the position that the sums of Rs. 4,38,472 and Rs. 2,27,342 were wholly or in part terrible to any sale of stock-in-trade and as such within the meaning of the profits.
12. Even if the transaction is regarded as of a composite nature to acquire all the assets of the machine company with the object of establishing a company for manufacture of diesel engines in India, it is a capital nature. As the entire assets of the machine company had to be purchase, both its plant and machinery and its finished products and parts had to be parched. The composite transaction being of a capital nature, if any gain ultimately, the amount will be in the nature of capital gain and not by way of revenue income.
13. Our answer to the question referred to us in the affirmative. The revenue will pay the costs of the assessee-company.
14. Question answered in the affirmative.